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How Do Mutual Funds Work

How Do Mutual Funds Work
If you are interested in mutual fund investing and curious about how it can work for you, this will be an insightful read.
Omkar Phatak
Mutual funds are popular and safer options, compared to stock investments. They too come with their share of risks but they are a lot lesser, in comparison to other options. The lowering of risk is attributed to the fact that these funds invest your money by following the diversification principle, of not placing all your eggs in the same basket. They choose only the best and safest baskets for your eggs to grow and hatch eventually. That is, they distribute and invest money, in such a way, that it has multiple opportunities to grow. So, if you are looking for steady growth of your investments, they are an ideal option. They are well-suited for people who want to have a long-term investment and see their wealth growing steadily.
What is a Mutual Fund?
It is a collective investment fund, wherein, individual contributions of all investors are pooled in, to invest in diversified security options and profits from proceeds are shared among them. This is roughly how they work. In United States of America, a mutual fund as an idea and investment tool began operating in 1924. There are many types of funds and one needs to know the terminologies and intricacies of investment before going ahead.
How Do They Work for Investors?
Here is a step-by-step analysis of their working for investors.
Step 1: You Buy Shares
The fund companies advertise their investment schemes and issue shares of their investment plans, along with information on expected growth rate. You can buy these shares directly from the company or through brokers.
Step 2: Money is Pooled in
The monetary contributions of all shareholders like you, are pooled in, to create capital for investment.
Step 3: Money is Invested in Different Types of Securities
The total money pool is used by fund managers to invest in diverse kinds of securities. These securities may be in the stock market, futures market, the forex market, or may even be investments in infrastructure.
The fund manager decides, in which areas your investments are made. You have no say whatsoever, in the investment decisions. You are only entitled to returns on your investment. The income or commission of the fund manager is dependent on profits from investment. So, you have to think and invest wisely, as once the money is invested and placed in hands of the fund manager, you have no control. So, there is a risk in this investment, but much lesser due to diversification.
Step 4: You are Paid Profit Dividends Periodically
Periodically, the manager gives you a report of the fund's proceeds and performance. You are paid dividends periodically, depending on profits that the fund makes, on collective investment. The costs involved in operating of funds, including marketing, distribution, investment advisory services, and other costs, are also transferred to the investor. That is, the returns or dividends you get, are calculated after these costs have been subtracted. All these charges and costs like managements fees, non-management expenses, service fees, and brokerage commissions are categorically called load charges.
There are many types of these funds, based on the type of securities, they invest money in and the kind of restrictions they have on share transactions. While investing, check the history and performance of a company in detail. Look at the growth versus value ratio, that they are offering, and the ratings. All these details are supplied in the prospectus, offered by mutual funds. Learn to read the fine print in detail, to avoid repentance later. Check the fee table and future projected returns carefully.